Bankruptcy: 401K Loan Repayment With Bad Faith

Consumers who are in dire financial straits are likely to discover that their retirement savings could be jeopardized by filing for bankruptcy.  Under federal code, bankruptcy 401k loan repayments are not necessarily allowed when the courts work to determine how much money a family has available under the “means test.”

What is the Means Test?

The means test can apply to both Chapter 7 and Chapter 13 personal bankruptcies. It involves a determination of how much money a family has available to pay obligations on a monthly basis. How it works varies based on the chapter bankruptcy filed as followed:

• Chapter 7 – The means test is only applied to a Chapter 7 bankruptcy case if a family earns more than the average household within a state. The test itself creates a budget for expenses based on how much the IRS believes a family should spend on things such as housing. If the family’s actual expenses exceed the amount allowed, the IRS will count the overage as income that can be used to pay other obligations.
• Chapter 13 – The means test is applied to all Chapter 13 bankruptcy cases to determine how much money a debtor has left over to pay creditors at the end of the month. Expenses that exceed the allowable amount will pose a problem for debtors. For example, if the IRS allows $1,000 for housing and utilities, but a family spends $1,500 a month, the court will say the $500 extra must be applied toward bills. This means a family in Chapter 13 will have to lower housing and utility expenses or consider a move to less expensive accommodations.

How it Applies to 401k Repayment

If a debtor has an outstanding 401k loan, the court will not consider repayment as part of the means test. This means the money set aside for loan repayment will be required to be applied to another debt, rather than the 401k. In essence, the debtor will not be able to repay that loan under Chapter 13 bankruptcy.

Ramifications of Failing to Pay

When a 401k loan is not repaid, a debtor will face potential ramifications in the form of taxes owed on the money. The bankruptcy court, however, will not take this into account either.

Contacting a Lawyer

Bankruptcy 401k issues can be difficult for consumers to work through. It is best to contact an experienced lawyer to gain advice on how to proceed when there is an outstanding 401k loan and bankruptcy is a desired action.